Few things take the joy out of taking on a new client like finding that they have been taking improper deductions. Even worse is when they say “we’ve been audited and the IRS didn’t say anything.” The IRS isn’t bound by its old mistakes, as a Minnesota couple learned yesterday in Tax Court.
The couple took an IRA deduction on their 2007 return. Unfortunately for them, they had no wage or self-employment income. You can only take an IRA deduction if you have such “earned” income. Ah, but they had been audited!
Petitioners contend that respondent determined the same issue in petitioners’ favor as to 2006, thereby establishing precedent. However, each taxable year stands alone, and the Commissioner may challenge in a succeeding year what was condoned or agreed to in a previous year. Auto. Club of Mich. v. Commissioner, 353 U.S. 180 (1957); Rose v. Commissioner, 55 T.C. 28 (1970). Thus, respondent’s concession of or failure to challenge the IRA deduction in a prior year does not necessarily entitle petitioners to the deduction in subsequent years.
If the deduction is improper, you don’t get a permanent private exception for it just because the IRS missed it before.
Cite: Niesen, T.C. Summ. Op. 2011-71
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to
Interesting case, Joe.
But this is a clear cut case i.e. you can’t take an IRA deduction without earned income.
What about issues that are capable of differing interpretations, like, for instance whether a loan is bona fide or whether or not a transaction has been completed for purposes of triggering the recognization of gain?
I think the taxpayers in those cases should be allowed to rely on the fact that the IRS auditor did not disallow the taxpayer’s treatment. In other words, the failure to disallow the taxpayers treatment is equal to the approval of such treatment.
Then again, those cases are facts and circumstances sensitive and the IRS would probably claim that any new case is to be examined de novo.
See the latter part of the June 20 Merck decision by the Third Circuit for a similar take on whether the IRS is bound by its mistake or inaction in earlier years.